Transparency and accountability are the indispensable pillars of any company that currently navigates through the evolving standards of sustainability, with regulatory frameworks adapting to meet the heightened expectations of stakeholders as they increasingly scrutinize organizations’ ESG performance.

The European Union (EU), a frontrunner in sustainable finance, has spearheaded this transformation through the introduction of the Non-Financial Reporting Directive (NFRD) and its successor, the Corporate Sustainability Reporting Directive (CSRD). This third article in our CSRD series aims to showcase the key differences between these two directives and what they mean for your company.

The Genesis: The Non-Financial Reporting Directive (NFRD)

Enacted in 2014, the NFRD marked a pivotal moment in the pursuit of enhanced transparency and accountability regarding non-financial performance. This directive mandated that large public-interest entities with more than 500 employees disclose a comprehensive array of non-financial information, encompassing environmental protection, social responsibility, human rights adherence, anti-corruption measures, and diversity within corporate boards.

The NFRD’s primary objectives were twofold:

1. Empowering stakeholders and investors with valuable insights into an organization’s value creation processes and potential risks facilitates informed decision-making.
2. We are fostering a heightened sense of responsibility towards social and environmental concerns and encouraging organizations to embrace sustainable practices proactively.

While the NFRD represented a significant stride towards sustainability reporting, it faced certain limitations. Notably, the directive allowed organizations to choose from various reporting frameworks, such as the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), and Climate Disclosure Standards Board (CDSB), among others. This flexibility, though well-intentioned, inadvertently hindered comparability and consistency across reports, potentially undermining the directive’s overarching goals.

Furthermore, the NFRD limited its scope to a relatively small subset of companies, exempting a substantial portion of the corporate landscape from these reporting obligations. As the urgency to address sustainability challenges intensified, it became evident that a more comprehensive and harmonized approach was necessary.

Introducing the CSRD and expanding scope of companies

In April 2021, the European Commission proposed the Corporate Sustainability Reporting Directive (CSRD) in recognition of the need for a more comprehensive and inclusive framework. In addition to addressing the NFRD’s shortcomings, this directive ushers in a new age of sustainability reporting that places greater emphasis on accountability, comparability, and consistency.

The CSRD significantly broadens the scope, applying to all large companies and listed entities, including SMEs, except micro-enterprises operating within the EU and regardless of their legal form.

Large companies are defined as those meeting at least two of the following criteria: over 250 employees, a net turnover of more than €40 million, or a balance sheet total exceeding €20 million. This expansion is expected to bring approximately 49,000 companies under the directive’s purview, a substantial increase from the 11,600 companies previously covered by the NFRD.

Changes to reporting requirements

Under the CSRD, companies must adhere to more detailed and standardized reporting requirements. The CSRD also introduces the use of European Sustainability Reporting Standards (ESRS), ensuring consistency and comparability across reports. 

The CSRD has introduced several significant enhancements to the reporting requirements.

Double Materiality Concept

Organizations will be required to report on both the impact their operations have on society and the environment (impact materiality) and the sustainability risks they face (financial materiality). This dual perspective ensures a comprehensive assessment of an organization’s ESG performance and its potential vulnerabilities, such as those arising from climate change or resource scarcity. 

Long-term ESG Goals and Policies

The CSRD mandates the formulation and disclosure of long-term environmental, social, and governance objectives and policies. This requirement encourages organizations to adopt a strategic approach to sustainability, aligning their operations with broader societal goals and stakeholder expectations.

Due Diligence and Supply Chain Transparency

Recognizing the interconnectedness of global supply chains, the CSRD emphasizes the need for due diligence across an organization’s operations and its supply chain. This measure aims to promote transparency and accountability throughout the entire value chain, ensuring that sustainability considerations permeate every aspect of an organization’s activities. 

Disclosure of intangible assets

The directive introduces a requirement for organizations to disclose information related to intangible assets, such as social, human, and intellectual capital. This acknowledgement of non-financial assets reflects the growing importance of these factors in determining an organization’s long-term success and sustainability.

Alignment with sustainable finance regulations

The CSRD requires organizations to report in accordance with the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy Regulation. This alignment ensures consistency and coherence across various regulatory frameworks, facilitating a more comprehensive understanding of an organization’s sustainability performance. 

Integrated reporting and external assurance

To enhance credibility and transparency, the CSRD mandates integrated reporting, which combines financial and non-financial information into a single, cohesive report.

One of the significant changes in the CSRD is the mandatory requirement for third-party assurance of sustainability reports. Unlike the NFRD, which did not mandate external audits, the CSRD requires limited assurance to verify the reliability of the disclosed information. This step aims to enhance the credibility and accuracy of sustainability reporting. 

Digital tagging and machine readability

 In a move towards enhanced accessibility and data-driven decision-making, the CSRD introduces the requirement for digital tagging and formatting of sustainability reports using the European Single Electronic Format (ESEF/XHTML). This measure enables advanced data analysis and facilitates the integration of sustainability information into investment processes and decision-making frameworks.

Timeline Differences for Implementation

 The CSRD’s phased approach to implementation represents a significant shift from the NFRD’s more immediate requirements. Under the NFRD, companies had a set timeline to comply with the reporting requirements from the directive’s effective date, which allowed limited flexibility for gradual adaptation. The CSRD, on the other hand, introduces a staggered timeline, progressively encompassing a wider range of entities over several years.

This phased implementation begins with large public-interest entities already under the NFRD umbrella, giving these companies a head start in 2024. By 2025, the requirements will expand to include all large companies, further broadening the scope. Listed SMEs see a significant expansion in 2026, albeit with additional time to adapt. Finally, non-listed SMEs have the option to voluntarily comply by 2028, reflecting a more inclusive yet flexible approach.

Businesses can progressively build and refine their reporting processes with this staggered timeline, facilitating a smoother transition.

 It acknowledges the varying capacities of different types of entities to meet these enhanced requirements, thereby supporting a more comprehensive and systematic integration of sustainability reporting across the corporate landscape. This methodical approach under the CSRD ensures that companies have sufficient time to enhance their data collection, governance, and reporting mechanisms, ultimately promoting higher standards of transparency and accountability in sustainability practices.

Implications for Companies’ Sustainability Strategies

The CSRD represents a pivotal moment in the journey towards a more sustainable future, where transparency, accountability, and responsible business practices are fundamental imperatives. By embracing this paradigm shift, organizations can contribute to the creation of a more resilient, equitable, and prosperous society while safeguarding their long-term viability and competitiveness in an increasingly sustainable global economy.

The transition from the NFRD to the CSRD marks a significant milestone in the pursuit of enhanced transparency and accountability in the realm of corporate sustainability. While the NFRD laid the foundation for non-financial reporting, the CSRD represents a comprehensive and harmonized approach that addresses the limitations of its predecessor.

The CSRD is expected to bring in a new era of sustainability reporting by providing stakeholders with insightful data and encouraging an increased sense of responsibility among enterprises. This is due to its broadened scope, strict reporting standards, and focus on comparability and consistency.

As businesses navigate this transition, they must embrace a proactive mindset, investing in data management capabilities, supply chain due diligence, and the integration of ESG factors into their enterprise risk management and strategic planning processes. They can not only mitigate risks and ensure compliance, but they can also unlock opportunities for innovation, competitive advantage, and long-term value creation.

The road ahead may be challenging, but the rewards of embracing sustainability and transparency are manifold. Organizations that prioritize ESG integration, stakeholder engagement, and continuous improvement will be well-positioned to thrive in the evolving regulatory landscape and meet the growing expectations of stakeholders.